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FX Forecast Update

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Time for change? Not yet

Fri, Nov 14 2008, 16:06 GMT
by Danske Research Team

Danske Bank A/S

• We revised our FX forecasts in-between our regular forecast updates on 24 October; see Revised FX Forecasts: G10 and EM. Most notably, we raised all our short-term USD forecasts and pencilled in more JPY and CHF strengthening, along with more SEK and NOK short-term weakness. As risk sentiment was deteriorating sharply and no obvious triggers for an end to this was in sight, we considered it likely that things could worsen further. The rapid rise in risk aversion has stopped - albeit remains at a high level - and the immediate drivers for further JPY and CHF appreciation have thus faded. Unfortunately we called off our predicted rise in EUR/GBP too early as we - in line with most other forecasters - underestimated the amount of negative news already priced into the pound at a time when sterling denominated assets were heavily sold off.

• We remain guided by the dual themes of a financial crisis and a global recession. Recent data has further confirmed the outlook of the global economy falling into recession and we do not expect global activity to begin to expand until H209. Key data will continue to be depressed and both household and business conditions are likely to worsen further as access to credit has been severely tightened. Demand for fiscal stimulus is increasing but implications for fiscal sustainability remains unsettled. We do not see a significant bettering of financial conditions before well into 2009 and it is still too early to dismiss the possibility of a new wave of financial distress. Accordingly, we still see support to the counter-cyclical currencies CHF, JPY and USD - especially in the short term. However, given the reduced systemic risk seen since our last forecast update, we have opted to pencil in less CHF and JPY strength, implying a higher USD/JPY and EUR/CHF forecast profile.

• On the longer horizon - going well into 2009 - we anticipate financial conditions to improve gradually. That is, despite global production likely to have slumped around 2-3%, governments likely to have presented new rescue packages, this time focused more on fiscal initiatives, additional private institutions probably de facto nationalised, and those countries most burdened by external deficits and financial distress likely to be under the wings of the IMF. We do not expect to see a sharp recovery in risk appetite but rather a slow and cautious normalisation leading to lower but still elevated risk premiums. Price formation will continue to be influenced by ill-functioning markets and likely also the beginning of increased regulation limiting the possibility of a repetition of the 2002-2007 years. We anticipate seeing the USD strengthening further, but the JPY and CHF losing steam.

• Our most notable forecast change is for EUR/GBP. We have revised our EUR/GBP forecast upwards across all horizons but have kept our bias for a stronger pound in the longer run. The Bank of England's recent massive rate cut of 1.5% and the subsequent readiness to cut rates to 'whatever level needed' have made us revise our base rate forecast downwards, see BoE cuts 150bp - more to come. The fact that prospects for consumption, house prices and growth in general have turned even gloomier has convinced us that the pound will see no support in the near term. We believe however that the undervalued pound represents good value in the longer term and will benefit from a normalisation in risk sentiment, see Is GBP still interesting after downbeat Inflation Report?

• Download full Forecast Update with charts

Published on  Fri, Nov 14 2008, 16:18 GMT